SEC Publishes Unprecedented Proposed Rule on Climate-Related Disclosures

ISAAC FUHRMAN BORGMAN—On March 21, 2022, the U.S. Securities and Exchange Commission (SEC) revealed a long-anticipated rule to enhance and standardize climate-related disclosures for investors among public companies.

Under the unprecedented rule, the SEC would require a registrant to disclose information about: (1) the governance of climate-related risks and relevant risk management processes; (2) the reasonable likely material impact of identified climate-related risks on the business and consolidated financial statements; (3) how any identified climate-related risks has affected or may affect the strategy, business models or outlooks; and (4) the impact of climate-related events and transition activities on a registrant’s consolidated financial statements, and assumptions used in the audited financial statements. The SEC incorporated in the proposed rule frameworks, concepts, and vocabulary from the widely used Task Force on Climate-Related Financial Disclosure (TCFD) and Greenhouse Gas (GHG) Protocols.

In measuring the registrant’s GHG emissions, disclosures will require direct emissions (Scope 1), indirect GHG emissions from purchased electricity and other forms of energy (Scope 2), and indirect emissions from upstream and downstream activities in a registrant’s value chain (Scope 3). However, understanding that metrics of Scope 3 may be difficult to collect, the SEC is delaying the Disclosure Compliance Date for Scope 3 metrics to Fiscal Year 2024 (filed in 2025).

The requirements are not limited to domestic registrants. Foreign private issuers would be impacted by the proposed rule under the premise that climate change risk extends beyond domestic operations and financial conditions.

Despite a lack of current SEC requirements to do so, today more than half of the S&P 500 companies disclose climate risks in annual reports and 71% disclose Greenhouse Gas (GHG) emissions in their annual reports, sustainability reports, or company websites. In its letter to investors, the “Big Three” asset managers required public companies to implement climate risk reporting and disclosures. The SEC, however, considers voluntary reporting to be inconsistent in depth and specificity of disclosures across industries and within the same industry.

The biggest challenge to companies may be in sourcing accurate data. A Deloitte survey of executives at large public companies found that data availability and data quality remain the greatest challenge with respect to climate-related risks disclosures for over half of the respondents. Moreover, a strong majority of the respondents believe that additional resources are needed to generate better disclosures, which will result in higher compliance costs.

SEC Chair Gary Gensler supported the proposal and noted that “it would provide investors with consistent, comparable, and decision-useful information for making their investment decisions, and it would provide consistent and clear reporting obligations for issuers.” The proposed rule was cheered on by climate groups and investment managers that expressed a need for consistent ESG reporting metrics.

On the other hand, SEC Commissioner Hester Peirce opposed the proposed rule as its lone dissenter. She disagreed that the proposal would lead to comparable, consistent, and reliable disclosures due to unreliable data and assumptions. The Commissioner also criticized the requirement to include disclosures that companies consider immaterial for lack of a materiality nexus.

Instead, Commissioner Peirce argues that the SEC lacks authority to enact the rule under our First Amendment jurisprudence. Her theory is that the rule prescribes specific content for the compelled speech that the rule mandate, and that such disclosures lie outside the “subject-matter boundaries” Congress imposed.

Private and public parties have expressed objections to the proposed rule, including the U.S. Chamber of Commerce and the American Petroleum Institute. Additionally, lawyers that represent corporations and investors warned that the proposal may be a potent source of securities fraud litigation and last June, a group of 16 Republican state attorneys general raised objections in a letter to Chairman Gensler.

Impacted parties, advocates, and critics have sixty (60) days to participate in public comments, and the SEC may revise the proposal before holding a second vote to finalize the regulation. Given the unprecedented requirements, lack of reliable methods, and need for costly resources, the SEC may ultimately propose more feasible demands instead.